Upload
paula-harris
View
67
Download
2
Tags:
Embed Size (px)
DESCRIPTION
Ch 11: Monopoly and Monopsony. In the Perfectly Competitive market, the individual firm or consumer had no effect on the market price A monopolist or monopsonist has market power; the market price is affected by their choice of quantity - PowerPoint PPT Presentation
Citation preview
1
Ch 11: Monopoly and Monopsony
•In the Perfectly Competitive market, the individual firm or consumer had no effect on the market price
•A monopolist or monopsonist has market power; the market price is affected by their choice of quantity
•A monopolist or monopsonist must then choose q to maximize their profits, given that p depends on q.
2
Chapter 11: Monopoly & Monopsony
In this chapter we will cover:
11.1 Monopoly Features11.2 Monopolistic Profit11.3 Monopoly Supply11.4 Inverse Elasticity Pricing Rule11.5 Welfare Effect of Monopolies11.6 Why Monopolies?11.7 Monopsonists
3
A MONOPLY is an industry where there is only ONE producer/seller.
The monopolist is the market; they face the market demand curve P(Q).
By lowering price, the monopolist is able to sell more goods.
4
A monopolist faces the market demand curve:
P=f(Q) ie: P=a-bQ
A monopolist’s revenue is equal to:TR=PQ
ie: TR=aQ-bQ2
A monopolist’s costs increase with production:
TC=f(Q)ie: TC=Q2
5
A monopolist’s profit is the difference between total revenue and total cost:
Profit=TR-TCIe: Profit=aQ-bQ2-Q2
The monopolist's profit maximization problem:
Max (Q) = TR(Q) - TC(Q) Q
6
If MR > MC, the monopolist is increasing profit and should produce
If MR< MC, the monopolist is decreasing profit and should not produce
Therefore (like PC), the monopolist maximizes profits when MR=MC.
7Q
Q
TR
TC
Profit
D
MC
MR
P
MR=MC
8
Demand: P=20-2QMR=20-4QMC=5+Q
MR=MC5+Q=20-4Q
5Q=15Q=3
P=20-2qP=14
9
When a monopolist increases production, 2 things occur:
1)The monopolist earns MORE revenue from the extra goods sold
2)The monopolist earns LESS revenue from the previous goods sold due to a reduced price:
Q
PQPMR
Q
PQQP
Q
TRMR
10
Revenue Change: Q increases to Q2
Demand
Revenue Lost on units
Q
P
Q2
P2
Q1
Revenue gained on new units
P1
Therefore marginalrevenue is less thanprice.
11
A monopolist facing demand curve P=28-2Q originally produces 10 units. Calculate the revenue gained and lost by moving to 11 units.
P(10)=28-2(10)P(10)=8P(11)=6
Revenue gained = P(11) = 6Revenue lost =[P(10)-P(11)]10Revenue lost = (8-6)(10)=20
12
Marginal Revenue and Linear Demand
Q
P
Demand: P=100-4Q
When demand is linear, MR has a slope twice as steep.
MR=100-8Q
13
For the monopolist,
AR(Q)=TR(Q)/QAR(Q)=P(Q)
Or, since price is found on the demand curve,
AR(Q)=D
Since MR is always below the demand curve,
AR(Q)>MR(Q)If Q>0
14
1)The Monopolist will produce Q where MR=MC
2)Given this Q, the monopolist will charge a price determined by their demand curve
3)Monopolist profit is equal to:TR-TC
OrPxQ-ACxQ
Or(P-AC)Q
15
Price
Quantity
Demand curve
MR
20
80
MC
AC
20
100
50
e
Profit
16
The Monopolist does not have a suply curve!
Why?
For the Perfect Competitor, price is exogenous; taken as given.
For the Monopolist, price is endogenous; it is part of the Monopolist’s decision.
17
Price
QuantityD2MR220
80
MC20
D1
MR1
Here the monopolist offers 20 units at 2 different prices, dependent on demand
Therefore, no supply curve exists
18
We can rewrite the MR curve as follows:
MR = P + QP/Q = P(1 + (Q/P)(P/Q))
= P(1 + 1/)
where: is the price elasticity of demand, (P/Q)(Q/P)
19
Using this formula:
When demand is elastic ( < -1), MR > 0When demand is inelastic ( > -1), MR < 0When demand is unit elastic ( = -1), MR= 0
Therefore, The monopolist will always operate on the elastic region of the market demand curve
20
Example: Elastic Region of the Demand Curve
Quantity
Price
a/2b a/b
aElastic region ( < -1), MR > 0
Inelastic region (0>>-1), MR<0
Unit elastic (=-1), MR=0
21
Since at equilibrium, MC=MR:
*
*1
**
)1
1(*
P
MCP
MCPP
PMC
IEPR:The monopolist’s markup above MC (as a percentage of price) is the negative inverse of elasticity of demand
22
Example:
= -2 MC = $50
a. What is the monopolist's optimal price?
MR = MC P(1+1/) = MC P(1+1/(-2)) = 50 P* = 100
23
Since at equilibrium, MC=MR:
*
*1
**
)1
1(*
P
MCP
MCPP
PMC
IEPR:The monopolist’s markup above MC (as a percentage of price) is the negative inverse of elasticity of demand
Note: The IEPR is related to the Lerner Index of Market Power…….
24
While a firm may be a monopoly, its MARKET POWER, or control over price may be limited.
-Perhaps people don’t really need the good
-Perhaps imperfect substitutes exist
The Lerner index of market power measures market power; the control a firm has over price
25
Lerner Index =(P-MC)/P=-1/
The Lerner Index lies between 0 and 1
The Lerner Index is 0 for a perfectly competitive firm (P=MC, the firm has no control over price).
26
Shifts in market demand
•A shift in market demand will cause the monopolist’s MR curve to shift also
•This will cause a new equilibrium (MR=MC)
•This new equilibrium will cause a new price
27
Price
Quantity
D0
MR0
Q0
P0
MC
D1MR1
P1
Q1
•Here an increase in demand increased monopoly price and quantity
28
An ice cream monopolist with a MC curve of MC=Q originally faced a demand curve of P=20-2Q. Due to an increase in temperature, demand shifted to P=35-2Q.
Calculate the change in price and quantity due to this shift in demand.
29
ORIGINALLY: P=20-2QMR=20-4Q
MR=MC20-4Q=Q
4=Q
P=20-2QP=20-2(4)
P=12
30
AFTER DEMAND SHIFT: P=35-2QMR=35-4Q
MR=MC35-4Q=Q
7=Q
P=35-2QP=35-2(7)
P=21
31
The shift in demand caused:
-An increase in monopoly price of $9 ($21-$12)
-An increase in quantity produced of 3 cones (7-4)
32
Shifts in marginal cost
•A shift in marginal cost will create a new equilibrium (MR=MC)
•This new equilibrium will cause a new price
•Increases in cost will always raise price and decrease quantity supplied for a monopolist
33
Price
Quantity
D0
MR0
Q0
P0
MC
MC1
P1
Q1
•An increase in cost increases monopoly price and decreases quantity supplied
34
• We saw before how a perfectly competitive market maximized consumer and producer surplus
• Since a monopoly decreases output to increase prices, a monopoly will normally create a DEADWEIGHT LOSS:
35
MC=S
Demand
MRQM
PM
PC
QC
CS with competition: A+B+CPS with competition: D+E
A
B C
D
E
36
MC=S
Demand
MRQM
PM
PC
QC
A
B C
D
E
DWL = C+E
CS with monopoly: A PS with monopoly:B+D
37
Since PM>AC for most Monopolists, they earn ECONOMIC PROFIT. There is an incentive for a monopoly to maintain market power.
RENT SEEKING is any activity aimed an creating or preserving monopoly power:
Government lobbying/bribesAdvertisingHiring Thugs
This rent seeking behaviour is a social cost beyond simple deadweight losses
38
MC=S
Demand
MRQM
PM
PC
QC
A
B C
D
E
DWL = C+E
Maximum rent seeking cost=B+D
39
Monopolies exist for a number of reasons, some “good”, some “bad”:
Natural Monopolies Barriers to Entry
Structural Legal Strategic
40
A natural monopoly exists in an industry with INCREASING RETURNS TO SCALE:
One large firm is a natural monopoly if it can supply the total market at a lower total cost than any other 2 firms:
41Quantity
Price
Demand
AC
If total market quantity is 45,000, one firm has a natural monopoly
Example: Natural Monopoly
45,00022,500
42
Q
Price
Demand
AC
If total market quantity increased to 80,000, the natural monopoly might not stand
Example: Natural Monopoly
80,00040,000
43
Normally, if economic profit is available in an industry, firms will enter until that profit is pushed to zero.
A BARRIER TO ENTRY is any factor that allows a firm to earn positive economic profit while making it unprofitable for another firm to enter
44
A structural barrier to entry is a cost or demand advantage that prevents another firm from entering
-Cost Advantages (includes natural monop.)
-Positive Externalities (iTunes/Ebay)-Advertising/Brand Dominance(Kleenex, Heinz)
-May be seen as strategic barrier
45
A legal barrier to entry exists when a firm is legally protected from competition.
-Patents (encourages research)-Exclusive Rights
-ie: Marijuana growers-ie: Out-of-country vehicle
inspections (ie: Canadian Tire)-ie: Printing Money (Canadian
Mint)-ie: Degrees (Universities)
Often these barriers are set up for good reasons
46
A strategic barrier to entry exists when a firm takes EXPLICT steps to prevent entry
-Operating at a loss/reduced profit-Developing a Predatory Reputation-”Unofficial” agreements to maintain
monopoly-Consumer Contracts-Incompatible inputs (ie: Phone
numbers, memory cards, software, chargers, etc.)
47
MC=S
Demand
MRQM
PM
PC
QC
If PX was still
profitable to the monopolist, it could keep other firms out of the market.
Lowering profits to avoid competition
PX
PC Losses
48
A MONOPSONIST is a single buyer of a good or input.
-ie: Only the government purchases military equipment (we hope).
-If the film Teenage Mutant Ninja Star Spidermen 4: The Ballet of the Forgotten Princess were to film in Edmonton, there’d be 1 film but many people wanting to be extras
-The monopsonist faces the market supply curve
49
Marginal Product (MP) is the additional productivity of another unit of input.
-ie: 1 more worker increases output by 7
Marginal Revenue Product (MRP) is the additional revenue of another unit of input.
-ie: 1 more worker increases revenue by $21 (if each output sells for $3)
MRP=P x MP
50
Since the monopsonist faces the market supply curve, it can only increase inputs (ie: Labour) by increasing the price
To hire another worker, the monopsonist both has to give that worker a higher wage, plus increase the wage of every other worker:
L
wLwMEL
51
Monopsonist Increases Labour:
Supply
Wage increase of current workers
L
W
L2
W2
L1
Wage of additional workersW1
52
If supply of any input is linear, the Marginal Expenditure (ME) if that input has TWICE the slope of the supply curve.
Ie:
Supply: W=50+3QME: W=50+6Q
53
If, for the next input (worker) MRP>ME, the firm should use that input, as the input will earn the firm more than it increases costs.
If, for the next input (worker) MRP<ME, the firm should not use that input, as the input will earn the firm less than it increases costs.
Therefore a monopsonist maximizes when MRP=ME
54
Monopsonist Maximization:
Supply
L
W
W*
L*
MRPL
MEL
ME=MRP
Wage
55
A film crew comes to the city to hire extras. It faces a supply curve of:
W=10+Q
Extras have a marginal revenue product curve of
W=100-2Q
Maximize the film’s hiring of extras.
56
Supply: W=20+QME: W=20+2Q
ME=MRP20+2Q=100-2Q
4Q=80Q=20
W=20+QW=20+20
W=40
57
Welfare Effects of Monopsonists:
Supply
L
W
W*
L*
MRPL=DPC
MEL
PCConsumer Surplus
Wage
PCProducer Surplus
58
Monopsonist DWL:
Supply
L
W
W*
L*
MRPL=DPC
MEL
MonopsonistConsumer Surplus
Wage
MonopsonistProducer Surplus
DWL
59
Chapter 11 SummaryA monopoly consists of one firm selling a goodA monopolist faces the market demand curve
To sell more, it must decrease priceMR is therefore less than demand
A monopolist chooses quantity where MC=MRThis quantity is sold at a price found on the demand curveThis typically produces a profit
60
Chapter 11 SummaryA monopolist always operates on the ELASTIC portion of the demand curve
The elasticity of demand determines a monopolist’s market power through the Learner Index of Market Power
Monopolies cause deadweight lossThis loss increases if Monopolies spend resources to maintain their monopoly
Monopolies exist due to barriers to entry (structural – includes natural monopoly - strategic, legal,
61
Chapter 11 SummaryA monopsonist is a single BUYER of a good or inputMonopsonists deal with the market supply curveMonopsonists operate where marginal revenue product equals marginal expenditure (MRP=ME)Monopsonists cause Deadweight loss
**Remember that Deadweight Loss could be a reason for government intervention, but that intervention itself carries a cost